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ECONOMIC RECOVERY - Shadow of Secular Stagnation Darkens U.S. Outlook

Shadow of Secular Stagnation Darkens U.S. Outlook 05-20-14 Bloomberg Brief

Five years into the recovery, the debate rumbles on about whether growth will take off, or if the U.S. is in a new normal of secular stagnation.

Having previously focused on:

1. The Great Recession,
2. The housing recovery, and
3. Fiscal Reform,

the economic policy debates in the U.S. have recently turned towards the question of whether longer-term trends are preventing a return to previous growth rates.

EIGHT YEARS

Recent work by H arvard University professors Carmen Reinhart and Kenneth Rogoff has extended the analysis on the after-effects of financial crises. According to their research into 100 different financial crises, the average time it takes for an economy to recover from a systemic banking crisis and re-attain its previous level of income is eight years.

Depending on how one weights the depth of the most recent crisis and the various components of the U.S. policy response over time – sustained monetary stimulus, financial restructuring, initial fiscal stimulus, and subsequent fiscal austerity through sequestration – the U.S. economy might be expected to hit that eight-year average or perhaps do a bit better. Indeed, Reinhart and Rogoff claim that as measured by per capita GDP, the U.S. and Germany are the only two of 12 economies to have completed this cycle already.

Still, measures such as rate of GDP growth and U.S. employment continue to disappoint, and broader hopes for a speedy and full U.S. recovery to growth above 3 percent have been repeatedly dashed. The intervening external shocks from Europe (the sovereign debt crisis) and Japan (the Fukushima disaster) have no doubt contributed, but another culprit seems to be the continued travails of the U.S. housing market, which has conspicuously underperformed once again this year.

SECULAR STAGNATION

Economists such as former Treasury Secretary Lawrence Summers have raised the more alarming prospect of a deeper issue: secular stagnation. In a speech at the IMF last November, he noted that given the depth of the recession and the rapid recovery in financial conditions, the U.S. economy should have rebounded more sharply than normal after the crisis. His comments suggest that the downward shift in growth is not a recent phenomenon, but rather the result of longer-term trends. He focuses on figures dating back to the 1980s, but there is also evidence that over the last 70 years, the rate of GDP and total job growth has tended to decline in successive business cycles, as the time-series chart shows.

The trend appears even grimmer when expressed as an average per-quarter GDP growth rate: the averages for GDP and jobs have declined by factors of 4 and 7, respectively, since World War II. As has been widely discussed, the two most recent recoveries have been marred by disproportionately weak job growth, which presents its own puzzles but has been attributed in part to innovations in technology and globalizing labor markets.

The recent problems in the labor market seem daunting indeed, and the U.S. is far from anything like a societal consensus, but the robust public debate about labor slack and education reform gives some grounds for hope, if not exactly optimism, in that area.

Another sign of secular stagnation is the remarkably smooth downward trend of the quarterly GDP growth average in successive recoveries. While the labor market’s ability to rebound has varied some over time, the decline in overall growth rates has been steady, coinciding with the maturing of the U.S. physical capital base and, later on, both the labor market challenges noted above and declines in population growth and labor force participation.

Summers went on the record last year advocating a variety of widely discussed reforms that target many of these issues, ranging from demand-side (infrastructure spending) to supply-side (education, tax reform, entitlement reform), but that doesn’t seem to have moved the political debate.

If the political establishment remains indifferent, the Fed is likely to keep policy rates low for a whole lot longer than the “some time” it has predicted so far.

COMMERCIAL REAL ESTATE - Commercial Mortgage-Backed Securities: Hot ... But Very Dangerous

"With $367 billion of CMBS loans maturing in 2015 - 2017, do not assume that things will just work out. Clients of yours who hold CMBS securities need to think seriously about unloading them while the market is still liquid."

A SHOCK COMING: Retail commercial real estate sector – Only 7% think that values will drop.

SOURCE: Commercial Mortgage-Backed Securities: Hot ... But Very Dangerous 05-20-14 Keith Jurow via DShort

Introduction

On May 6, Crain's New York Business published an article entitled "CMBS market comes charging back to life." The author pointed to "a growing comfort level among investors with CMBS." With Wall Street also touting the improved health of the commercial mortgage-backed securities (CMBS) market, now is a good time to take a good look at this important topic. Has the CMBS market really returned to normal after its precipitous collapse starting in 2008?

Investor Bulls Are Euphoric

Investors in commercial real estate are more bullish than they have ever been. Take a good look at this chart from Marcus & Millichap's Commercial Real Estate Investment Outlook for the first quarter of 2014.

Source: Marcus & Millichap

This chart reveals nothing less than investor ebullience. 71% of investors in multi-family apartments believe that the value of their investments will increase over the next twelve months. A tiny 4% think that values will decline. Investors are the least optimistic about the retail commercial real estate sector – a whopping 7% think that values will drop.

The report goes on to point out that more than two thirds of those investors polled believe that commercial real estate offers "favorable returns relative to other investment classes." More than half believe that commercial properties have bottomed out.

Are there any fundamentals that could cause investors to moderate their bullish expectations? I could not find any which the report mentions. The chief strategy officer for Marcus & Millichap concludes the report by saying that

"Given the alternative investment options, the next several years are going to be very, very positive for commercial real estate."

CMBS Delinquency Rate Continues to Decline

Investors are very confident that their euphoria is built on solid ground. Aren't there any good reasons for their optimism?

That is a fair question. Let me give you one key factor that the bulls usually point to in support of their position. The delinquency rate on CMBS has been declining since it peaked in the summer of 2012. Take a look at this impressive drop in the delinquency rate just over the last year.

Source: Trepp

Doesn't this decline suggest an improved market? I must admit that the drop in the last 12 months has been huge. Let me explain why the decline is not all that significant.

The dollar figure through April 2014 for CMBS delinquent loans is $34.1 billion. That is down substantially from the $49.7 billion in May 2013. This also looks very positive, doesn't it?

Well ... not quite. Let's dig a little deeper. You need to keep in mind that the delinquent loans figure excludes all those loans which are past their balloon due date but are current on their interest payments. This factor is extremely important.

The percentage of loans which are delinquent is not the most important figure for investors. In my Capital Preservation Real Estate Report, I discussed in detail Morningstar's very important CMBS Delinquency Report. Let's take a good look at their more recent March 2014 report.

Morningstar's Watchlist is the crucial component of the report. It deserves some close examination.

The list starts with all loans which are delinquent, in foreclosure, already foreclosed (REO), placed with a special servicer, or whose borrower is in bankruptcy. This is a much broader picture of distressed loans. But it doesn't end here.

Added to this list are loans where updated financial reports indicate "potential problems." This could be a significant cash flow decrease since the loan's origination, a decline in the occupancy rate, or a pending loss (or bankruptcy) of a significant tenant.

As of February 2014, the Watchlist total of loans that are potentially heading for default was $134.7 billion -- more than four times the delinquent loan figures.

The Game of Extend and Pretend

In 2009, the banking regulators created a game which quickly became known as "extend and pretend." When a borrower defaults on a loan within a CMBS, the master servicer will usually transfer the debt to a special servicer for further action. The special servicer has considerable discretion in determining what course of action might provide the greatest net return to the lender. As the crisis deepened after the bankruptcy filing of Lehman Brothers, special servicers were flooded with delinquent and defaulted loans. They had to determine what action was in the best interest of the investor. Although foreclosure was chosen as the best route for some loans, this was not done to any great extent. The alternatives became known as "workouts."

Instead, the servicers searched for ways to modify the loan so it could return to being "current." This included extension of the loan if the borrower was able to continue making payments. The terms of the loan were often modified by reducing the interest rate, offering interest-only payments, or even cutting the balance owed. Loans could be completely restructured -- sometimes in the most bizarre manner.

More recently, a discounted payoff (DPO) is often selected. This is done if the special servicer believes the underwater property will not regain its value before the balloon is due and that a DPO will provide a greater net return to the investor than a foreclosure. The borrower had to come up with the cash to pay off the note at the agreed-upon discount.

Although these workout games managed to avoid a mountain of foreclosures that might have buried the CMBS market, they simply kicked the can down the road. Wall Street is confident that these workout strategies will continue to work their magic. After all, didn't the loosening of standards by the regulators prevent a banking collapse in 2009?

Notwithstanding this unbridled optimism, I remain very skeptical that the kick-the-can-down-the-road game provides any real solution. Let me explain why.

Paying the Piper: CMBS Loans Coming Due

One of the main reasons that the CMBS delinquency situation does not seem to be a major problem now is that the worst is yet to come. The problem is heavily concentrated in the loans originated or refinanced during the three craziest years of the bubble: 2005 - 2007.

Morningstar's March 2014 delinquency report points out that loans issued during these years account for 85% of all delinquent CMBS mortgages. Although the prices of CMBS loans in the secondary market have rallied substantially since the bottom, most of the borrowers are still underwater with their property. Take a good look at this chart showing the amount of CMBS loans coming due.

Source: Goldman Sachs and Trepp

You can see that it is in the next three years -- 2015 - 2017 -- when the great bulk of CMBS loans will be coming due -- $367 billion. The vast majority of them are ten-year mortgages originated during the bubble years of 2005 - 2007.

To say that underwriting standards disappeared during these three years is an understatement. Let me give you a better sense of what happened.

In 2004 before the market really heated up, the average loan-to-value ratio (LTV) on CMBS loans reported by the Big Three rating agencies was roughly 87%. This figure rose in each of the succeeding three bubble years.

By the end of 2006, most deals were being underwritten with LTVs of 100%. A year later, the average LTV had soared to roughly 110%. This means that lenders were writing loans which exceeded the appraised value of the property. That was total insanity and a recipe for disaster. Yet hardly anyone seemed to worry.

Debt Service Coverage Ratios (DSCR) plunged as completely unrealistic rental growth projections were permitted. The result was that enormous dollar amounts of loans were underwritten which would not have passed muster only a few years earlier.

Take a good look at this chart from Moody's showing the shocking decline in underwriting standards during these three bubble years.

One last key factor – Roughly 80% of the loans had interest-only terms with no amortization built in to protect against balloon payment risk. So when you read about balloon payments coming due in 2015 - 2017, keep in mind the quality of the loans we are talking about.

Investing in Distressed CMBS Loans

A sale of the note is one of the options which special servicers use if they believe it will net the lender more than a foreclosure might. There are quite a few funds which focus on purchase of distressed commercial real estate notes.

The most important and largest provider of a secondary market is DebtX. They are very important for sellers because DebtX helps them to value the loan. Since most of these loans are relatively small and very idiosyncratic, the assistance and data provided by DebtX enables them to price the loan as accurately as possible to increase the chance of finding a willing buyer.

Here is the biggest danger for unwary buyers which you need to understand. The market distinguishes between "non-performing" loans and "impaired performing" loans. Is this splitting hairs? Not at all.

Non-performing loans are usually seriously delinquent loans on the balance sheets of banks which are no longer accruing interest. However, the banks also have impaired loans which they still consider to be performing and continue to accrue interest. They have what are called well-defined weaknesses, but accrue interest because the bank considers them to be "well secured" by the collateral. Good luck trying to figure out if a loan is well-secured.

This difference between a non-performing loan and an impaired but performing loan is crucial for the note buyer. Take a good look at this updated graph from DebtX's January 2014 market report.

Let me explain. The graph shows the difference between the average price of impaired but performing loans and that for non-performing loans. This spread has fluctuated between 25 and 30 percentage points for more than two years. At the end of 2013, the spread widened to more than 30.

What this means is that a buyer would have to pay 30 percentage points more for an impaired performing loan than for a non-performing loan. That is a huge difference. Here is my question: How many investors can really distinguish between these two kinds of distressed loans? Not many. I am not sure that I could distinguish them.

If your clients are seriously considering investing in distressed commercial real estate notes, they would need to be able to differentiate one from the other. Otherwise, they could easily overpay for what was considered to be an impaired performing loan but was really a distressed loan where the likelihood of full repayment was highly questionable. Do you want them to take that risk?

My Advice for You:

For a year now, I have tried to give my subscribers a sense of how ugly the 2008 – 2009 crash was for investors. In the summer of 2009, Cornerstone Advisors published an article which reported the complete collapse of commercial real estate liquidity in April and May 2009. For those two months, less than $3 billion in commercial property sales were completed.

You must keep in mind that a record $522 billion in commercial property had been sold in 2007. In the spring of 2009, sellers refused to drop their asking prices sufficiently to meet the demands of the few buyers out there. Throughout the nation, the real estate market had essentially seized up.

I urge you to disregard the bulls and, in the interest of your clients, think carefully about risks. With $367 billion of CMBS loans maturing in 2015 - 2017, do not assume that things will just work out.

Clients of yours who hold CMBS securities need to think seriously about unloading them while the market is still liquid.

Those clients of yours who may be considering purchasing CMBS ought to picture the market as a minefield ahead without any markers. Leave the risk-taking to others.

DOLLAR TREE - Uptick in its earnings before following economic downturns

Dollar Tree Earnings 05-22-14 BI

Dollar Tree (DLTR) this morning reported first quarter earnings, and shares of the company are up about 7%.

The company said that same-store sales grew by 2%, or 1.9% when excluding the impact of the Canadian dollar. Management said it expects its same store sales for 2014 to grow by low-single digits. 

Following Dollar Tree's report, dollar store peers Dollar General (DG) is rallying and Family Dollar (FDO) is barely in the green. 

It might be tempting to conclude that strength in the dollar stores is a bad sign for the economy. This chart from Family Dollar's January investor conference, paints an interesting picture of what makes these discount retailers go. Family Dollar has seen an uptick in its earnings before income tax, or EBIT, following economic downturns. 

But recent U.S. economic data has painted the picture of an economy that is growing, even if that growth hasn't been as robust as many would expect. 

The move higher in dollar store stocks comes during what has been a busy week for retail stocks. The XRT ETF that tracks the S&P Retail index losing about 1% this week, underperforming the S&P 500's 0.8% gain.  

In more specific instances, companies in the retail sector have sent investors mixed messages. Luxury retailers Coach (COH) and Tiffany (TIF) saw their shares go in different directions after their most recent reports: Coach sank, Tiffany soared.

High-end organic grocer Whole Foods (WFM) got smoked after its earnings report. But retail giant Wal-Mart (WMT), which has announced clear intentions to drive down the price of organic food,  also fell after its results, which disappointed. 

So the question for investors is if the economy continues to make incremental improvements, what story is retail really telling, and might discount retailers go from here?

Dollar General is set to report first quarter results on June 3. 

RETAIL CRE - E-Commerce Industry Is About To Explode

The E-Commerce Industry Is About To Explode 05-22-14 BI

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To absolutely no one’s surprise, it looks like America’s online shopping obsession will continue unabated.

A new report from Forrester Research says that online retail sales in the U.S. are expected to grow more than 57% to $414 billion by 2018, up from the $263 billion e-retail accounted for in 2013. With this jump, online sales will make up approximately 11% of all retail sales.

According to Forrester, millennials are playing a crucial role in this growth. As a generation that was raised with the Internet, 25 to 33 year-olds in particular are doing more of their spending online than any other age group. As this generation enters its prime spending years, its impact on eCommerce will magnify.

The report also notes the profound impact that the proliferation of mobile devices is having on ecommerce, as consumers are increasingly choosing to make purchases via mobile phones and tablets. While U.S. mobile retail sales accounted for only $8 billion in 2013 (that’s 3% of online sales and less than 1% of all retail sales), Forrester expects mCommerce to grow 33% annually through 2017.

While online retail’s pure revenue potential is certainly impressive, let’s not ignore the growing impact computers, smartphones, and tablets are having on in-store purchases, as well. With more and more retailers developing omnichannel strategies encompassing both digital and analog touch points, the bond between online and in-store is intensifying. In other words, eCommerce platforms are having a compound effect on sales.

Undoubtedly, there is also a host of challenges that accompany the precipitous rise of online sales. As the last 6 months have clearly demonstrated, even the largest retailers are still susceptible to fulfillment issues and cyber security breaches. (As Target’s recent struggles have highlighted, the repercussions of such breaches can be extremely damaging and wide-ranging.) In addition, companies must continuously enhance capabilities like site performance, mobile optimization, and user experience in order to stay competitive. This requires innovative strategic planning and, often, significant investment.

As online sales continue to be an increasingly critical revenue source, U.S. retailers will look to build out their digital capabilities. But cutting edge companies understand that these capabilities will not only enhance online sales, they will help them find bold new ways to connect their digital and in-store experiences.

RETAIL CRE - ailers' Profits Miss By Most In 13 Years: "Consumer Is Not Back"

Retailers' Profits Miss By Most In 13 Years: "Consumer Is Not Back" 05-23-14 Zero Hedge

"The American consumer is not fully back and remains cautious," is the oddly real tone of Ken Perkins, president of Retail Metrics, reporting that U.S. retailers’ first-quarter earnings are trailing analysts’ estimates by the widest margin in 13 years amid weak spending by lower-income consumers intensified competition:

• *U.S. RETAILERS’ PROFITS MISSING ESTIMATES BY MOST IN 13 YEARS
• *U.S. RETAILERS MISSING ESTIMATES BY 3.2%, RETAIL METRICS SAYS

While extreme weather is tossed out as the reason for this miss, what is an ugly smoking gun is the expectations the chains are missing had already been significantly lowered. Hope remains strong as "pent-up demand" has analysts projecting a 8.6% surge in profits in Q2... as long as it's not too hot or cold or wet or dry.

As Bloomberg reports,

Chains are missing projections by an average of 3.2 percent, with 87 retailers, or 70 percent of those tracked, having reported, researcher Retail Metrics Inc. said in a statement today. That’s the worst performance relative to estimates since the fourth quarter of 2000, when they missed by 3.3 percent. Over the long term, chains typically beat by 3 percent, the firm said.

...

“The American consumer is not fully back and remains cautious,” Ken Perkins, Retail Metrics’ president, wrote in the report.

...

What’s more, the expectations the chains are missing have been significantly lowered. While analysts now project retailers’ earnings fell an average of 4.1 percent, back in January they had estimated a 13 percent gain.

Most retail segments are showing profit declines, with department stores, teen-apparel chains and home-furnishing stores faring the worst, Retail Metrics said. About 41 percent of retailers have missed estimates, while 45 percent have beat.

But faith remains strong that it will all be ok...

Improved weather, pent-up demand and better employment trends may help the industry in the second quarter, Perkins said. Analysts are projecting an 8.6 percent gain in profit for the current three-month period, he said.

Unforntunately, the winter of 2000 was a relatively mild one - so we wonder what they blamed the miss on then...

RETAIL CRE - More Disappointing Results

• On Monday afternoon, Urban Outfitters reported that sales at its namesake store plunged 12% during the first quarter. "While Anthropologie and Free People continue to deliver record levels in sales and profits, Urban Outfitters had a disappointing quarter and is working diligently to regain its fashion footing," said CEO Richard Hayne. URBN fell 8.8%.
• Dick's Sporting Goods announced weaker-than-expected quarterly sales and earnings. "Our difficulties this quarter were isolated to two categories: golf and hunting," said CEO Edward Stack. "After a very challenging first quarter in golf last year, we expected some further headwinds and only modest improvement, but instead we saw a continued significant decline. In the case of hunting, we planned the business down based on last year's catalysts, but it was even weaker than expected." DKS plunged 17.9%.
• The TJX Companies, which owns T.J. Maxx and Marshalls, also announced weak financial results. "For the first quarter, our consolidated comparable store sales increased 1%, and our earnings per share of $.64 were slightly below our expectations with a negative impact from foreign currency exchange rates that was larger than our guidance assumed," said CEO Carol Meyrowitz. "While sales were not as strong as we would have liked, predominantly in our apparel business, I was very pleased that overall business trends improved as the quarter progressed." TJX fell 7.6%
• Caterpillar disclosed that its rolling 3-month sales through April tumbled 13%. Latin America; Asia/Pacific; and Europe, Africa and Middle East (EAME) also saw sharp declines during the period. Caterpillar is recognized as a bellwether of economic activity. CAT declined 3.6%

RETAIL CRE - Dick's Sporting Goods

Dick's Sporting Goods Has A Solution For Disappointing Sales 05-20-14 BI

Dick's shares are tanking following disappointing sales numbers. The company said that weak golf and hunting sales led to the decline. 

Dick's Sporting Goods is expanding clothing offerings for women. 

The company plans to open specialty stores for women in its existing retail locations.

"Think a colorful wall of sports bras, vibrant tables filled with color coded tees/tanks, and racks organized by specific needs, like running jackets and yoga pants," the company told Business Insider in an email. "Accessories will also have a designated space, so women can match everything from their socks, to their gym bags, to their headbands."

The expanded product offerings will also be online.

With the advent of brands like Lululemon, Gap's Athleta, and Under Armour, demand for women's athletic apparel is soaring like never before. 

But the brand faces a ton of competition from retailers who have already established themselves with female clientele. 

The mounting competition has even begun to threaten Lululemon, long seen as the paramount purveyor of fitness clothing for women. 

In an earnings conference call with analysts, Dick's CEO Ed Stack said that the women's business has the most growth potential of any segment. He also cited youth and footwear as growth opportunities. 

The company also has the advantage of partnerships with mega-brands like Adidas, Nike, and Under Armour. 

Shares Of Dick's Sporting Goods Are Getting Clobbered Today — And This Map Explains Why 05-20-14 BI

Dick's Sporting Goods (DKS), one of the nation's largest golf retailers, this morning reported earnings and sales that disappointed, citing notable weakness in its golf and hunting segments. 

Dick's shares are off more than 15% following its report. Shares of golf-club maker Callaway Golf (ELY) are also down about 4% following the report from Dick's. 

Dick's CEO Edward Stack said the company expected a modest improvement in its golf segment during the first quarter, but instead saw declines. Same-store sales at its Golf Galaxy stores fell 10.4% during the quarter. In the prior year period, same-store sales at Golf Galaxy fell 11.8%. 

"Our difficulties this quarter were isolated to two categories: golf and hunting. After a very challenging first quarter in golf last year, we expected some further headwinds and only modest improvement, but instead we saw a continued significant decline. In the case of hunting, we planned the business down based on last year's catalysts, but it was even weaker than expected," Stack said. 

A report from GOLF 20/20 helps explain the pain. Total rounds played in February fell 4.6% from the prior year, with rounds played in the West North Central and Mid Atlantic regions, which endured historically cold and snowy winters, falling by more than half.

RUSSIA - Russia And China Sign Historic $400 Billion "Holy Grail" Gas Deal

Russia And China Finally Sign Historic $400 Billion "Holy Grail" Gas Deal 05-21-2014

There was some trepidation yesterday when after the first day of Putin's visit to China the two countries did not announce the completion of the long-awaited "holy grail" gas dead, and fears that it may get scuttled over price negotiations. It wasn't: moments ago Russia's Gazprom and China's CNPC announced, that after a decade of negotiations, the two nations signed a 30 year gas contract amounting to around $400 billion. And with the west doing all it can to alienate Russia and to force it into China's embrace, this is merely the beginning of what will be a far closer commercial (and political) relationship between China and Russia.

So far there have been no public pricing details on the deal which accrording to Gazprom CEO Aleksey Miller is a "commercial secret", and which is believed to involve Russia supplying 38 billion cubic metres of gas per year to China via a new eastern pipeline linking the countries.

According to Itar-Tass, the compromise between Russian gas export monopoly Gazprom and Chinese National Petroleum Corporation (CNPC) on Russian gas price is estimated at $75 billion, citing the Deputy Head of the National Energy Security Fund Alexei Grivach. The differences on the price for 38 and 60 billion cubic meters supplies a year were $1.5 billion and $2.5 billion, he added, so the subject of the negotiations is quite a significant one.

Gazprom expected a base price of $400 for 1,000 cubic meters, an expert of the Eurasian Development Research Center of the Chinese State Council said in April, whereas the CNPC’s proposal was $350-360 for 1,000 cubic meters.

RIA has more details:

According to Miller, only at 4 am local time it became clear “that all the principal issues have been solved.”

Russia and China have foreseen providing “preferential tax regimes,” Miller told journalists, without giving details.

Russia earlier suggested nullifying the extraction tax for gas fields delivering fuel to China, while Chinese officials expressed their readiness to cancel import taxes on gas from Russia, Rosneft CEO Igor Sechin said Tuesday.

Gazprom’s stocks rose 0.9 percent following reports that the long-awaited gas supply contract was signed. Russian stocks increased Tuesday amid positive aftermath of the first day of President Vladimir Putin’s visit to Shanghai.

In March 2013, Gazprom and CNPC signed a memorandum of understanding on the planned gas supplies to China along the eastern route via the Power of Siberia pipeline. The signing of the contract has been delayed several times as the two sides failed to reach an agreement citing a pricing issue as the main stumbling block. President Putin’s current visit to China became the final stage of the negotiating process.

The Gazprom CEO said earlier the company could receive advance payment from China for the gas, which could start flowing as early as 2018. The planned project has an estimated capacity to pump up to 38 billion cubic meters annually, which could later increase to 60 billion cubic meters.

Then this from from RT:

A memorandum of understanding was signed in the presence of Russian President Vladimir Putin and President of China Xi Jinping on the second day of Putin’s two-day state visit to Shanghai. The price China will pay for Russian gas remains a "commercial secret" according to Gazprom CEO Aleksey Miller. Gas will be delivered to China's via the eastern 'Power of Siberia' pipeline.

RT producers were informed of the landmark energy deal prior to its signing after a conversation with Miller. 

Under the long-term deal, Gazprom will begin providing China's growing economy with 38 billion cubic meters of natural gas per year for the next 30 years, beginning in 2018. The details of the deal were discussed for more than 10 years, with Moscow and Beijing negotiating over gas prices and the pipeline route, as well as possible Chinese stakes in Russian projects.

Just ahead of Putin's visit to Shanghai, Russian Prime Minister Dmitry Medvedev gave reassurance that the agreed price would be fair.

“One side always wants to sell for a higher price, while the other wants to buy for a lower price,” Medvedev said. “I believe that in the long run, the price will be fair and totally comparable to the price of European supplies.”

A major breakthrough in negotiations came on Sunday as Gazprom chief Aleksey Miller sat down with his CNPC counterpart, Zhou Jiping, in Beijing to discuss final details, including price formulas.

Although Europe is still Russia's largest energy market – buying more than 160 billion cubic meters of Russian natural gas in 2013 – Moscow will use every opportunity to diversify gas deliveries and boost its presence in Asian markets.

“I wouldn’t look for politics behind this, but I have no doubt that supplying energy to the Asia Pacific Region holds out a great promise in the future,”Medvedev said.

In October 2009, Gazprom and CNPC inked a framework agreement for the Altai project which envisions building a pipeline to supply natural gas from fields in Siberia via the western part of the Russia-China border.

In March 2013, Gazprom and CNPC signed a memorandum of understanding on Russian gas supplies to China along the so-called eastern 'Power of Siberia' route. When both pipelines are activated, Russia can supply Asia with 68 billion cubic meters of gas annually.

Last year, China consumed about 170 billion cubic meters of natural gas and is expected to consume 420 billion cubic meters per year by 2020.

Regardless of what the final price ended up being, and whether or not China got the upper hand in the negotiations, the final outcome is there and it is real: as a result of his disastrous foreign policy in the past two months, Barack Obama finally pushed Russia into China's hands, culminating with a deal that was ten years in the making and was never certain, until the Ukraine crisis. 

And yes, this was all predictable from day one. Here is what we said precisely two months ago:

If it was the intent of the West to bring Russia and China together - one a natural resource (if "somewhat" corrupt) superpower and the other a fixed capital / labor output (if "somewhat" capital misallocating and credit bubbleicious) powerhouse - in the process marginalizing the dollar and encouraging Ruble and Renminbi bilateral trade, then things are surely "going according to plan."

For now there have been no major developments as a result of the shift in the geopolitical axis that has seen global US influence, away from the Group of 7 (most insolvent nations) of course, decline precipitously in the aftermath of the bungled Syrian intervention attempt and the bloodless Russian annexation of Crimea, but that will soon change. Because while the west is focused on day to day developments in Ukraine, and how to halt Russian expansion through appeasement (hardly a winning tactic as events in the 1930s demonstrated), Russia is once again thinking 3 steps ahead... and quite a few steps east.

While Europe is furiously scrambling to find alternative sources of energy should Gazprom pull the plug on natgas exports to Germany and Europe (the imminent surge in Ukraine gas prices by 40% is probably the best indication of what the outcome would be), Russia is preparing the announcement of the "Holy Grail" energy deal with none other than China, a move which would send geopolitical shockwaves around the world and bind the two nations in a commodity-backed axis. One which, as some especially on these pages, have suggested would lay the groundwork for a new joint, commodity-backed reserve currency that bypasses the dollar, something which Russia implied moments ago when its finance minister Siluanov said that Russia may refrain from foreign borrowing this year. Translated: bypass western purchases of Russian debt, funded by Chinese purchases of US Treasurys, and go straight to the source.

Here is what will likely happen next, as explained by Reuters:

Igor Sechin gathered media in Tokyo the next day to warn Western governments that more sanctions over Moscow's seizure of the Black Sea peninsula from Ukraine would be counter-productive.

The underlying message from the head of Russia's biggest oil company, Rosneft, was clear: If Europe and the United States isolate Russia, Moscow will look East for new business, energy deals, military contracts and political alliances.

The Holy Grail for Moscow is a natural gas supply deal with China that is apparently now close after years of negotiations. If it can be signed when Putin visits China in May, he will be able to hold it up to show that global power has shifted eastwards and he does not need the West.

* * *

To summarize: while the biggest geopolitical tectonic shift since the cold war accelerates with the inevitable firming of the "Asian axis", the west monetizes its debt, revels in the paper wealth created from an all time high manipulated stock market while at the same time trying to explain why 6.5% unemployment is really indicative of a weak economy, blames the weather for every disappointing economic data point, and every single person is transfixed with finding a missing airplane.

To conclude with the traditional geopolitical balance of power summary: Putin wins (again), Obama loses (again), and the monument to the dollar's status as world's reserve currency gets yet another tarnishing blow.

RUSSIA - Russia And China Sign Historic $400 Billion "Holy Grail" Gas Deal

Where The CapEx Is: Russia To Invest $55 Billion In Gas Deal, China Another $20 Billion 05-22-14 Zero Hedge

Western companies have buybacks that only reward shareholders here and now; the East actually spends capex to invest into the future. Case in point: today's "holy grail" gas deal announcement, which in addition to generation hundreds of billions in externalities for both countries over the next three decades will result in an immediate and accretive boost to GDP, to the tune of $55 billion for Russia and $20 billion for Beijing.

From Reuters:

Russia will invest $55 billion in gas exploration and pipeline construction to China, while Beijing will give roughly $20 bln to Moscow as part of the 30-year gas supply agreement, President Vladimir Putin said on Wednesday.

And incidentally we are not joking when we say that the New Normal is one in which the west spends on buybacks while the east spends on growth. Here is Goldman explaining just this back in february.

Economic recovery should equal a capex recovery; that is indeed one of the key defining characteristics of the recovery phase of a business cycle. Yet we believe that “this time will be different”, certainly for developed market-based companies. Why? A combination of structural, cyclical and technological changes suggest to us that the need for capex will be lower going forward, one of the key reasons why we are cautious on capital goods.

Things are getting smaller, faster, lighter…

Ceteris paribus you need a big machine to make a big and heavy widget and a small machine to make a small and light widget; and a big machine generally demands a bigger investment than a small one. This may seem trivial, but as miniaturisation gathers pace you need less powerful motors, less space, a smaller truck to transport it around, less material to build it and much more – all with negative implications across the capex chain. In conjunction with miniaturisation machines are getting faster. A robot today can make more widgets than it could yesterday.

…until they disappear all together

The lightest and smallest widgets of them all are the ones that are now entirely virtual. As recently as the last up-cycle in 2003-2006, some companies invested capex building plants that made CDs, DVDs, video games, sat navs, maps, time tables and much more, that we now largely use our smartphones/tablets for. While capex will continue to be invested to produce our smart phones/tablets, it is difficult to envisage how it will compensate for the increasing number of goods that are becoming virtual.

Capex will be spent elsewhere…in Asia

While all capex counts, the capex we typically focus on is the that spent by listed companies in general, and listed DM companies in particular. However, the global supply chain looks very different today than it did only 10 year ago. Everything from electric components to steel is being sourced from non-DM companies, often not listed, and many of them based in China and other parts of Asia. This trend is particularly strong within tech, where Asian companies dominate the capex-intensive part of the value chain. However, myriad small Asian companies play an important part in the supply chain of many non-tech DM companies. And often, the part of the value chain that is being outsourced is the most capex-intensive part, such as producing raw materials or semiconductors, reducing both the cyclicality and the need for capex by DM-listed companies.

…and by states and private companies

The Chinese State Grid Corporation spent c.US$60 bn in 2012 and China Railway Corporation spent over US$100 bn. To put this into context, the 2,200 European non-resource companies GS covers spent in aggregate €250 bn. Over the last decade, FAI has increased by a factor of 2.5x in EMs while it has increased by only 10% in DMs. This has increased the proportion of capex spent by SOEs in a number of industries such as resources, transport and power generation and T&D. All capex counts, but this capex will not show up in the cash flow statements of the companies in our coverage, and we expect a declining slice to show up in the P&Ls of our capital goods coverage.

Too much was spent in the last up-cycle

The last cycle saw many booming end-markets: mining, power generation, shipping, O&G and Chinese construction among many growing 3x+. We do not expect this up-cycle to contain any booms, and see several of the preceding end-markets continuing (or entering) multi-year declines. At the core of our view is the long asset life of many of the capital goods sold into the booming end-markets of the last decade. This lends itself to multi-decade investment cycles. The 20-year decline in transmission and power generation capex in the US (early 1970s to late 1990s) provides a sobering example. We now believe that several end-markets are close to, or past, their peak. Of the five mentioned above, it is only O&G where we still expect growth, albeit at a substantially lower level.

RUSSIA - Russia And China Sign Historic $400 Billion "Holy Grail" Gas Deal

RUSSIA - Chinese Meeting Results

China gives Putin a diplomatic boost 05-20-14 Associated Press By Louise Watt

China gives Putin a diplomatic boost with state welcome amid criticism, sanctions from West.

SHANGHAI (AP) -- President Vladimir Putin met Tuesday with China's president in a diplomatic boost for the isolated Russian leader but the two sides had yet to agree on a widely anticipated multibillion-dollar natural gas sale.

Putin, shunned by the West over Ukraine, met with Chinese President Xi Jinping at a start of a two-day meeting on Asian security with leaders from Iran and Central Asia. The Russian leader is hoping to extend his country's dealings with Asia and diversify markets for its gas, which now goes mostly to Europe.

Russia has been negotiating for more than a decade on a proposed 30-year deal to supply gas to China. Officials said they hoped to complete work in time to sign a contract while Putin is in Shanghai. But Putin's spokesman, Dmitry Peskov, said Tuesday it wasn't finalized.

"Significant progress has been reached on gas, but there are issues that need to be finalized regarding the price," Peskov said, according to Russian news agencies. He said a contract could be signed "at any moment."

A deal would give Moscow an economic and political boost at a time of Western sanctions, while pressure on Moscow is thought to give Beijing leverage to push for a lower price.

The U.S. treasury secretary, Jacob Lew, appealed to China during a visit last week to avoid taking steps that might offset sanctions. However, American officials have acknowledged China's pressing need for energy.

In a joint statement, Putin and Xi urged Ukrainians to start "broad nationwide talks" on ending their country's crisis. Russia has been pressing for such talks and they are an element of a peace plan proposed by European mediators. The Ukrainian government has refused to invite separatist rebels in the country's east to participate.

The statement appealed for global rules to limit use of computer technology to hurt state sovereignty, a reference to efforts to curb the spread of online opposition to authoritarian governments. Beijing tries to block material that criticizes one-party rule, while Moscow has tightened controls. An official said last week Russia might block access to Twitter.

Putin and Xi attended the signing of 49 cooperation deals in fields including energy, transport and infrastructure, but no details were given at the ceremony.

The price of gas is the sticking point in the proposed agreement between Russia's government-controlled Gazprom and state-owned China National Petroleum Corp.

A deal looked more likely after Washington and the European Union imposed asset freezes and visa bans on dozens of Russian officials and several companies.

The deal to pipe Siberian gas to China's northeast would help Russia diversify export routes away from Europe. It would help to ease Chinese gas shortages and heavy reliance on coal.

Putin told Chinese reporters ahead of his visit that China-Russia cooperation had reached an all-time high.

"China is our reliable friend. To expand cooperation with China is undoubtedly Russia's diplomatic priority," Putin said, according to the official Xinhua News Agency.

Xi and Putin were scheduled to kick off a joint exercise between their two navies in the northern part of the East China Sea.

The two countries developed a strategic partnership after the 1991 Soviet collapse, including close political, economic and military ties in a shared aspiration to counter U.S. influence, especially in Central Asia.

A tentative agreement signed in March 2013 calls for Gazprom to deliver 38 billion cubic meters of gas per year beginning in 2018, with an option to increase that to 60 billion cubic meters.

Plans call for building a pipeline to link China's northeast to a line that carries gas from western Siberia to the Pacific port of Vladivostok.

A gas deal would mean China would be in a "de facto alliance with Russia," said Vasily Kashin, a China expert at the Center for Analysis of Strategies and Technologies in Moscow.

In exchange, Moscow might lift restrictions on Chinese investment in Russia and on exports of military technology, Kashin said in an email.

"In the more distant future, full military alliance cannot be excluded," Kashin said.

"It will, however, take years for China to start playing in the Russian economy a role comparable to that of the EU," he said. "After that happens, both China and Russia will be much less vulnerable to any potential Western pressure and that, of course, will affect the foreign policy of both these countries."

In a joint statement after their talks, Putin and Xi said the two sides voiced serious concerns over the political crisis in Ukraine, and urged Ukrainian regions, people and political groups to start "broad nationwide talks," according to Russian state news agency ITAR-Tass. Their statement also said that any external attempts to forcibly interfere in Syria would be unacceptable.

RUSSIA - Chinese Meeting Results - #2

China Signs Non-Dollar Settlement Deal With Russia's Largest Bank 05-20-14 RT via ZH

Slowly - but surely - the USD's hegemony is being chipped away whether by foreign policy faux pas, crossed red-lines, or economic fragility. However, on Day 1 of Vladimir Putin's trip to China it is clear that the two nations are as close as ever. VTB - among Russia's largest banks - has signed a deal with Bank of China to pay each other in domestic currencies, bypassing the need for US Dollars for "investment banking, inter-bank lending, trade finance and capital-markets transactions." Kirill Dmitriyev the head of Russia’s Direct Investment Fund notes, "together it’ll be possible to discuss investment in various projects much more efficiently and clearly," as Russia's pivot to Asia continues to gather steam.

As RT reports, Day 1 for Putin is going well...

VTB, Russia’s second biggest lender, has signed a deal with Bank of China, which includes an agreement to pay each other in domestic currencies.

“Under the agreement, the banks plan to develop their partnership in a number of areas, including cooperation on ruble and renminbi settlements, investment banking, inter-bank lending, trade finance and capital-markets transactions,” says the official VTB statement.

The deal underlines VTB Group’s growing interest in Asian markets and will help grow trade between Russia and China that are already close trading partners, said VTB Bank Management Board Vasily Titov.

But it's not just the banking relationships...

In the first day of a two-day trip to China Russia’s President Vladimir Putin said the two countries will be increasing their bilateral trade to reach a new level.

“Our countries have done a huge job to reach a new historic landmark…. China has firmly settled in a position of our key trade partner,” Putin said.

Putin also said that trade turnover between Russia and China grew almost 2 percent during 2013 to reach about $90 billion.

“If we sustain this pace the level of bilateral trade of $100 billion will be reached by 2015 and we’ll confidently move on,” Putin said.

Increasing investment cooperation is crucial, Putin added.

...

“Together it’ll be possible to discuss investment in various projects much more efficiently and clearly,” as Interfax quotes Kirill Dmitriyev the head of Russia’s Direct Investment Fund.

RUSSIA - The Proposed Chinese Gas Pipeline

The Proposed Gas Pipeline That Has Russia-China Relations Stronger Than Ever 05-19-14 BI

Click to Enlarge

Russian President Vladimir Putin told Chinese media that the strength of Russia-China relations is at an all-time high as the two countries are reportedly finalizing a 30-year gas-supply deal.

"Now Russia-China cooperation is advancing to a new stage of comprehensive partnership and strategic interaction," Putin said. "It would not be wrong to say that it has reached the highest level in all its centuries-long history."

The gas deal, which has been on the table for over 10 years, would send 38 billion cubic meters of natural gas to China each year starting in 2018 with the potential to expand the annual capacity to 61 billion cubic meters.

China consumed about 170 billion cubic meters of natural gas in 2013 and set a target of up to 420 billion cubic meters a year by 2020.

Europe is Russia’s largest energy importer as it bought more than 160 billion cubic meters of natural gas in 2013, but tensions and sanctions over Putin's meddling in Ukraine have Russia looking elsewhere.

Consequently, the deal is huge for the Kremlin since natural gas represents nearly 60% of Russia's total exports.

Here's a look at Russia's existing supply lines to Europe.

CHINA - Russia's "Holy Grail" Gas Deal With China Now "Only One Digit Away

We have previously profiled the "holy grail" gas deal between Russia and China on several occasions, and noted last week how it is expected to be signed this week - pending some final price negotiations. It appears that was spot on as Reuters reports, Russian state-run Gazprom said it was still "one digit" away from finalising a 30-year gas supply deal with Beijing which is expected to crown Russian President Vladimir Putin's visit to China next week. On the heels of Russia's de-dollarization meetings, the coming week appears a crucial one for the history books of the US Dollar as reserve currency (or will China leverage Russia's need to diversify from Europe and stall the deal once again?)

As we have discussed in detail, Russia has been in talks with China to supply it with 38 billion cubic metres (bcm) of gas a year for more than a decade but the deal has been postponed repeatedly over price disagreements. And as Reuters reports, last week, state China National Petroleum Corp (CNPC) said that it and Gazprom had reached an agreement to sign a contract during Putin's visit but that the two sides had yet to iron out price differences.

Gazprom chief executive Alexei Miller confirmed in an interview on state Rossiya 24 television that the talks were in the final stage and only centred around base price.

"There is just one question - it's ... a starting, base price in the price formula which, it's remarkable, has already been fully agreed upon with our Chinese partners," Miller told news show Vesti on Saturday with Sergey Brilev.

"It's a very little more - to put in only one digit, and a 30-year contract to supply 38 bcm of gas from East Siberia to China will be signed," said Miller.

The question is - of course - will the price disagreements once again spoil the party...

With tensions high with the West over Russia's role in the Ukraine crisis, Moscow is eager to divert some oil and gas from European markets, part of its wider push to Asia.

...

About 80 percent of Gazprom's revenue comes from gas sales to Europe and analysts say that failure to clinch a deal with China, the world's top energy consumer, would expose its huge reliance on Western consumers and might strengthen Beijing's bargaining positions in the months to come.

Miller emphasized that the contract would be signed on mutually beneficial terms, adding that the sides had also agreed to start talks on a second route for Russian gas supplies to China after the current deal is signed.

As we noted previously, quid pro quo:

"Observers expect both leaders to take a united stand on major international issues, and Putin may seek China's support on Russia's dealings with Ukraine."

And also on the dollar as we reported in "Russia Holds "De-Dollarization Meeting": China, Iran Willing To Drop USD From Bilateral Trade." In which case expect random Chinese space rockets to mysteriously explode during take off too.

THE FED's "MANAGED" ASSETS APPRECIATION STRATEGY

GOAL: Finance the Government Debt

OBJECTIVES: Increase Attractiveness of Debt

1. Manipulate Interest Rates which over time inevitably distorts Price Discovery and consequentially Mispricies Risk
2. Drive Up Financial Asset Prices (Stock Prices and Bond Prices) through Fed Buying,
3. Higher Stock Prices:
   1. Higher Borrowing Collateral Values fostering Increasing Borrowing,
   2. Higher Stock Prices reduce Dividend Yields Making Bond Yields Attractive,
4. Higher Bond Prices:
   1. Higher Bond Prices means lower government financing payments,
   2. Bond Yields higher than stock dividends mean bond buying.
5. Higher Overall Asset Prices (Real Estate etc):
   1. Increases Collateral Borrowing Power,

RESULTS: Financial Repression

REMEMBER: Its about protecting and increasing Collateral Values ( ie more lending and stop potential defaults)

Volatility is all about Liquidity 05-22-14 Zero Hedge

The S&P 500 tried to pull back yesterday, but as usual the late day trading pushed the loss to just 65 bps.  This has become the normal market.  In 2012, volatility puttered at 12.77%.  In 2013 it fizzled down to 11.07%.  YTD we have crept up to 11.73%.   These metrics tell you to expect daily gains and losses to be +/- .75%.  Very Exciting.

What does this market remind me of?  I would say the nearest example is 2004-2006 when volatility cycled between 10-11%.  What do these two periods in time have in common?  Extremely easy monetary policy provided by the Fed.

The most powerful chart to show you the impact of Fed provided liquidity plots realized volatility against the steepness of the yield curve as measured by the spread between the 10y and 2y treasury rates.  As the fed keeps the front part of the curve low through the Fed Funds rate, the steepness is held high.  A steep yield curve induces investors to borrow at cheap shorter rates and buy riskier assets to earn a spread.  Party on while the Fed provides the punch bowl.

The current steepness of the yield curve is a great indicator for future market volatility

The red line above is the steepness inverted, so higher numbers represent the curve flattening or the Fed taking punch away from the party.  Low numbers say party on.  The blue is the trailing 90 day realized volatility of the S&P 500.  When the Fed says to party, the volatility stays abnormally low.

Key point to make in this chart is that the red line is two years behind the blue line so the red line starts at 1/31/1977 while the blue line starts in '79.   This implies that the tightening of monetary conditions or reduction in market liquidity takes about 2 years time in order for volatility to pick up.  If the curve can remain steep for another two years, then how large will the volatility dislocation become when the Fed does ease off the gas pedal?  Most punch bowls are provided for 2 years or less.  Right now we are in the 6th year of zero interest rate policy with a strong indication that they will maintain it well into 2015.  Maybe this time the volatility will come even before the Fed eases off the pedal?